VFX house Rhythm & Hues endures cash crunch

Three studios team to keep struggling shop's lights on

Rhythm & Hues Studios, long one of the biggest and most important of the industry’s visual effects companies and the creator of the digital animals and environments for “Life of Pi,” narrowly averted bankruptcy and outright closure over the last several weeks.

El Segundo, Calif.-based R&H, which employs around 1,400 people at six locations worldwide, becomes the second vfx company to face such a crisis after Digital Domain underwent a rapid bankruptcy in September. But where DD’s problems stemmed from overly ambitious expansion and financial manipulation, R&H fell victim to a simple cash crunch.

The crisis began when Universal’s “Snow White and the Huntsman” canceled part of its vfx contract with R&H. At that point, with R&D money already spent and staff already hired, it became clear that R&H would need an equity investor for overseas expansion as well as current obligations. Execs thought they’d found a company to take a minority stake, but the Digital Domain bankruptcy spooked potential investors, and the deal fell through.

Nevertheless, the company was caught short of cash. Some employees were asked not to come into work, and R&H’s studio clients began making emergency calls to other visual effects companies in case they had to pull their work.

That proved problematic. R&H, famed for its CG animals (credits include Oscar-winning vfx for “Babe” and “The Golden Compass”), uses proprietary software for character animation. Work-in-progress can’t simply be lifted from R&H and handed off to another studio; animation work would have to be restarted almost from scratch, imperiling release dates.

Fox, U and Warners stepped in and quickly agreed to find a financial mechanism to keep the doors open at R&H without making a direct — but the trio could not agree on next steps. Some studio execs wanted to press for better deals on existing vfx contracts; others objected that the last thing R&H — or the vfx industry in general — needed was further financial pressure. Two studios wanted to force R&H into bankruptcy. The third threatened to pull its work if that strategy was followed. These arguments went on for several weeks.

The stalemate was broken when Indian-owned vfx company Prime Focus committed to support R&H, which is also engaged in delicate negotiations with a Chinese company for a new project. Galloping Horse, which bought into Digital Domain, is not involved in the current R&H negotiations, according to sources with knowledge of the talks.

In addition to its El Segundo HQ, R&H has led the way in offshoring vfx, with two facilities in India, one in Malaysia, one in Taiwan and one in Vancouver. That a highly respected company that’s been so aggressive about pursuing tax incentives and lower labor costs abroad could get into such a cash crunch is alarming vfx pros.

Vfx studios, especially those in California, have long been squeezed by tax incentives elsewhere and lower labor costs in Asia and Eastern Europe. Managers at those companies also complain about late payment from studio clients, which can exacerbate financial stresses.

Many visual effects companies have eschewed credit or have been unable to obtain credit since the 2008 financial crisis and so are vulnerable to cash flow problems.

“The revenue in this business is really lumpy,” said an executive at another vfx studio, who asked not to be identified because of the sensitivity of the R&H negotiations. “Even if you make money on one show you burn it between shows to keep your team together.”

That can lead to a vfx company “buying a show”: Taking work at below cost simply to have some cash flow during the lull between big projects. That undercuts all visual effects companies and puts stress on the entire industry.

“Some of these shops are living show-to-show. You’re depending on the last show to pay for the next show,” said the vfx exec. “You end up in a cash crunch and then you get into negative cash flow. And negative cash flow is a death spiral. Even if you have credit, you can’t afford to use it because you’re under water.”

Numerous California vfx companies have closed in recent years, highly respected studios CafeFX and the Orphanage among them.